FOMC Meeting: Fed Talks Tough on Inflation

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Includes: UDN, UUP
by: Kathy Lien

For the second meeting in a row, the Federal Reserve left interest rates unchanged at 2 percent. By now, everyone should realize that the easing cycle has come to an end and that the next move by the Fed will be a rate hike and not a rate cut. There was only one dissenter - Fisher, who voted for a rate hike for the second meeting in a row.

The Fed is talking tough on inflation and their hawkish comments indicate that they are afraid of getting too excited about the drop in oil prices.

With oil prices trading below $120 a barrel, inflation expectations have eased but the Fed refuses to acknowledge it. The Fed is afraid that just as quickly as oil prices have fallen, they could rise once again. Their hawkish comments were meant to appease potential dissenters like Fed Presidents Stern and Plosser and to hold them back from voting in favor of a rate hike. However don’t expect the hawkish comments to translate into a rate hike anytime soon. It is no secret that oil is determining Fed policy. Now that crude prices have cracked below $120 a barrel, the noose around the Fed’s neck has been loosened.

On growth, the Fed warned that the downside risks remain but they do expect the prior rate cuts to stimulate the economy over the next few months. It may not be until the fourth quarter or early 2009 before we seen some reasonable signs of growth.

High oil prices act as a tax for consumers and businesses, but it goes both ways meaning that the drop oil prices also acts as a tax relief for consumers and businesses. With oil prices inching towards $100 a barrel, half of the Fed’s problems have been solved. Consumers and businesses will breathe a sigh of relief and their spending should start to slowly pick up as long as the downtrend in oil continues.

Yes, the US economy still has a lot of problems including a weak housing and labor market. New home loans are difficult to get, but if consumer spending recovers, the rest of the economy will follow along as well.

The US dollar has had a great run. Over the past month, it hit a 6 week high against the Euro and traded within a whisker of its 7 month high against the Japanese Yen. The dollar continued to rally up to the last hour before the August FOMC meeting. No one expected rates to be changed, but there was less dissent within the Federal Reserve, which has pushed the dollar lower. Although the dollar has bottomed and is set to break 1.50 in the medium term, it has become overbought and could rally before it turns lower once again.

Compare the changes to the last 2 FOMC Statements (key changes are highlighted):

Release Date: August 5, 2008
For immediate release

The Federal Open Market Committee decided today to keep its target for the federal funds rate at 2 percent.

Economic activity expanded in the second quarter, partly reflecting growth in consumer spending and exports. However, labor markets have softened further and financial markets remain under considerable stress. Tight credit conditions, the ongoing housing contraction, and elevated energy prices are likely to weigh on economic growth over the next few quarters. Over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth.

Inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities, and some indicators of inflation expectations have been elevated. The Committee expects inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain.

Although downside risks to growth remain, the upside risks to inflation are also of significant concern to the Committee. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Elizabeth A. Duke; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh. Voting against was Richard W. Fisher, who preferred an increase in the target for the federal funds rate at this meeting.

Press Release
Release Date: June 25, 2008
For immediate release

The Federal Open Market Committee decided today to keep its target for the federal funds rate at 2 percent.

Recent information indicates that overall economic activity continues to expand, partly reflecting some firming in household spending. However, labor markets have softened further and financial markets remain under considerable stress. Tight credit conditions, the ongoing housing contraction, and the rise in energy prices are likely to weigh on economic growth over the next few quarters.

The Committee expects inflation to moderate later this year and next year. However, in light of the continued increases in the prices of energy and some other commodities and the elevated state of some indicators of inflation expectations, uncertainty about the inflation outlook remains high.

The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time. Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh. Voting against was Richard W. Fisher, who preferred an increase in the target for the federal funds rate at this meeting.

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